Does a Positive Industry Outlook Translate Into Investing Opportunity in These 3 Companies?

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According to a recent IATA report, global air travel will rise by 5.4% in 2013 in spite of difficult macro-economic conditions in developed economies. Among all the regions, North America is expected to be the biggest gainer this year. IATA expects that all North American airlines will have combined profitability of $3.6 billion in 2013, an increase of $1.3 billion from the 2012 level.

I have picked Delta Air Lines (NYSE: DAL), US Airways Group (NYSE: LCC) and United Continental Holdings (NYSE: UAL), all of which are the leading players in this region, to analyze and see if they provide investing opportunity at current levels.

Fleet replacement - the key to save costs

Delta Airlines recently reported its first quarter results, with a net profit of $85 million against a net loss of $39 million last year. The first quarter is considered seasonally weak for airlines, but Delta made profits in the first quarter after 13 years. This was because of better management of maintenance expenses and reductions in rental and other expenditures.

The company is doing well in its $1 billion cost restructuring initiative, under which it is retiring older aircraft that require higher maintenance cost and replacing them with newer jets. Delta is expected to get around eight aircraft per month starting from September, which will replace its older fleet, mainly consisting of Boeing 757s. It is expected that this initiative will result in cost savings of $600 million in 2013.

According to the company’s guidance, its passenger revenue per available seat mile, or PRASM, for April may decrease by around 2% year over year. Though in March its PRASM growth rate of 2% was well below the company’s guidance of 5%, Delta was successful in posting a net profit of $300 million in this month, which is a record for the company.

Besides, PRASM is expected to improve from May onwards due to an increase in the bookings, and given its strong unrestricted liquidity of $5.4 billion, the company can go for share buyback and dividend in 2013. Considering all this, I recommend buying this stock.

Merger to reduce competition:

US Airways reported record first quarter results, with a net profit of $55 million. Its pre-tax margin of 1.6% showed a huge improvement of 230 basis points year over year. The major reason behind this is declining fuel costs. Although, in this quarter, PRASM was lower than the initial expectations, the demand for leisure travel was strong.

On the other hand, the company’s merger plan with AMR Holding is on track and is expected to be completed by September. It has already got merger approvals from Canada and Brazil, and is also expected to get the same from the EU, as both the US airways and AMR don’t have any direct competition routes between the EU to the US.

AMR Holding is the parent company of American Airlines, and through this merger US Airlines will gain American Airlines’ international operations. This will further help to reduce the impact of price competition from low cost carriers in the US. This merger will also bring additional opportunities in US-Latin American and US-Asia Pacific routes, as American Airlines has a greater presence in these routes. This merger will unlock synergies worth $1 billion annually by 2015.

Considering all these factors I recommend buying this stock.

Expenditure affecting profit:

United Continental recently posted a special charges-adjusted loss of $325 million in the first quarter, which is its worst loss since the first quarter of 2009. Although it’s operating revenue increased by 1.4%, it also led to an increase in operating expenses by 1.3%. The major reasons behind increased operating expenses were increased spending on maintenance material and personnel costs, which became a drag on the profits.

On the other side, the company’s strategy of fuel cost hedging affected its performance, due to declining fuel prices. It is estimated that its loss from derivatives related to fuel prices could be $110 million.

Talking about the positives, United should benefit from a favorable macro-economic environment and lower fuel prices. It is in the process of reducing operating costs by retiring older and less efficient aircraft. In the first quarter it received six Boeing 737-900 ERs and retired two Boeing 757-200s and three Boeing 737-599s. It will also receive around six new aircraft in the second quarter and will retire around twelve older ones. This addition will reduce its operating expenditure and will also enhance customer experience.

Looking at all these factors, I recommend holding this stock for now and waiting for more news before taking any new position.

Bottom-line:

Delta Airlines looks to be on track with its cost reduction initiative, which will generate around $600 million in 2013 and low fuel prices will further help it to improve the profitability this year.

For US Airways the biggest growth potential comes from its merger with the AMR group, which will make it the world’s largest airline and will provide significant synergy.

But things are not as good at United Continental, as it continues to face issues of higher operating expenses.

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Shweta Dubey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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